Dig Yourself Out of Debt

Camilla CornellOctober 25, 2010

In the red? Here’s how to get back on track.

Paul and Stacey Brown’s television broke down two Christmases ago—at the same time the Hamilton couple were confined to their house with their five-year-old, Ben, and baby Meaghan, who was awaiting heart surgery. “We couldn’t go out because if Maggie even caught a cold, the surgery would have had to be put off,”says Stacey.

So Stacey did something uncharacteristically reckless for someone who had come close to bankruptcy a few years earlier. “I told Paul to go out and buy the biggest TV he could find,”she says.

Soon the Browns were left with this debt, plus money still owed from when Paul had gone back to school, as well as money owed on a vehicle they had bought when their old one recently died. They also amassed a mound of expenses when waiting two weeks in a Toronto hotel for their daughter’s operation. And to top it off, Stacey’s maternity leave from her $50,000-a-year job as a municipal zoning officer ended just as Maggie returned from hospital, forcing her to quit. “My child needed full-time care,” Stacey says.

By August 2000 the Browns owed a whopping $42,000 and had realized it was time to regain control of their financial life. So they shared one car and axed the extras: lunches out, the separate Internet phone line and the supermarket-prepared foods they liked to buy. Paul even took a second job, and since then they’ve been shaving about $1,000 a month off their debt. “We’re doing our best,”says Stacey, “but we have no cushion.”

They’re not alone: Canadians are getting deeper and deeper in the red. A report based on data from Statistics Canada says that the average household debt climbed to 111 percent of disposable income in 1999, up from 93 percent in 1990.

In the last decade, the country’s outstanding credit-card balance has more than tripled, to almost $40 billion. “Savings and assets are being depleted as people now try to service their debts,”says Laurie Campbell, program manager for the Credit Counselling Service of Toronto. The result? Record numbers of Canadians are declaring bankruptcy—79,453 did so in 2001, a 28 percent increase from ten years earlier.

Some, like Stacey and Paul, have been bowled over by drastic circumstances: job loss, illness or divorce. But the problem in our society goes deeper than that, says Rosemary MacDonald, a budget counsellor with Family Services of Hamilton-Wentworth. “Frequently, people feel their success is judged by their home, car or clothes.”Indeed, the average size of a Canadian house has almost doubled since the 1940s, to nearly 1,500 square feet.

Add in frills unimaginable in earlier years, from more and bigger bathrooms to walk-in closets, central air-conditioning and whirlpool baths, as well as big-screen TVs, DVDs, microwaves and computers, all of which many Canadians consider essential, and you’ve got a lot of “things”that need paying for.

The problem isn’t confined to just one income bracket either. MacDonald has helped a range of people from single moms on social assistance to construction workers, bank managers and doctors, all with unmanageable debt loads.

“The strain can be overwhelming”says Campbell. “People feel they’re living with this ball and chain. All it takes for most families is for one person to lose his or her job and the struggle to tread water seems lost.”

But it’s not all bad news. Given the tools, most people can dig themselves out of debt. While it may hurt in the short term, it makes for a more secure future. Read on for some tips from financial-planning experts as well as people who’ve freed themselves from the debt trap.

1. Pay off high-interest debt. Ray and Evelyn Cohen* of Toronto admit that until a year or so ago, they “just didn’t think about”their credit-card interest rate. The same went for the fact that bank-account shortfalls were routed to their plastic, or that Evelyn often took months to submit work expenses purchased on credit. They did notice, however, that with about $20,000 owing on two credit cards, they were falling behind. The 18.9 percent interest rate added some $300 monthly. “It was ridiculous,”says Evelyn.

So the Cohens consulted a financial advisor, who recommended that, rather than using Evelyn’s yearly bonus as a windfall, they pay off one credit card with the $12,000 and then focus on paying off the second card. “We’ve learned our lesson,”says Evelyn.

If you can’t pay off your credit cards outright by using savings or guaranteed investment certificates, says Sara Curtis, coauthor of Cliffs Notes Getting Out of Debt for Canadians, roll the debt into a bank loan or to a lower-interest credit card, or even consider refinancing your mortgage.

A rule of thumb to strive for, advises Scott Hannah, executive director of the Credit Counselling Society of British Columbia, is that no more than 20 percent of your after-tax income should service consumer debt: credit cards, lines of credit and car loans or leases.

2. Downsize. When Tony and Cindy Cortona* quit government jobs in Toronto to move to Vancouver nine years ago, they went from making almost $100,000 a year to less than $30,000. “But we didn’t change our lifestyle,”says Tony.

Soon they were drowning in credit-card debt of $40,000. “We couldn’t even make the minimum payments,”recalls Tony. “I remember when the five bucks I spent at Safeway on milk and bread represented close to 80 percent of my net worth.”

After meeting with a nonprofit credit counsellor in 1997, the couple took drastic action. They moved from a 1,200-square-foot house to a 500-square-foot apartment, saving about $700 a month, and cut out extras like wine with dinner and movies out.

Tony admits he once felt like the crash savings program would last forever, but he made his final debt-loan payment last year. It’s crucial that you have an end in sight, says Charles Long, author of How to Survive without a Salary. “Who cares if the apartment is too small if it’s only for a year?”You may even realize that things you once considered essential are not.

How to Save $600 a Month

Avoid “dry-clean only”clothes.
Save $50 a month. Cut out cable. Save $40 a month. Dispense with Friday night
takeout. Save $80 a month. Nix those Starbucks coffee
breaks. Save $90 a month. Clip grocery coupons, buy
sale items in bulk, eschew prepared
foods, and try generic brands. Save $120 a month for a family of four. Brown-bag your lunch. Save $140 a month. Dispense with one club membership and jog, bike or swim. Save $50 a month. Borrow videos and books from the library. Save $30 a month (assuming four videos at $3.50 each and one $16 book).

—c. c.

3. Pinch pennies. Rather than looking at what you owe in the coming year—say, $5,000—think of it as $14 a day, says Lynn Biscott, a registered financial planner with Fernwood Consulting in Toronto. “Most people can manage that,”she says. “It may be as simple as packing your lunch instead of getting takeout.”

4. Get into a groove. Predictability is key, argues MacDonald. “If you can prorate your bills, do so, because then you’ll know what you’ll have to pay every month in gas or hydro.”A realistic budget should also factor in irregular expenses such as back-to-school clothes and new tires for the car. And be sure to make a list before you hit the grocery store. “Don’t get trapped into impulse buys,”she says.

Stacey and Paul Brown maintain predictability by visiting the bank only on Thursdays to withdraw their $200 “allowance.”They eschew credit cards and even Interac; when their cash is gone, “that’s it.”MacDonald approves: “Many people try to avoid taking money from the bank, so they $20 themselves to death and lose track of spending.”

5. Prepare for emergencies. “We were just getting ahead when the car died.”That’s a common refrain. But the fact is, says Toronto financial-industry consultant Joanne Thomas Yaccato, car and appliance breakdowns and home repairs should be expected. That’s why she recommends setting some cash aside for such emergencies. But since tying up a large amount of savings at a low interest rate makes little sense, Yaccato also recommends having a credit line available, so long as you have a stable salary and would be able to pay it back quickly.

6. Save now, buy later. Buying things the old-fashioned way can do a lot to keep you from taking on unmanageable debt. Cortona remembers the day he and his wife cut up their credit cards as a condition of becoming clients of a credit-counselling service.

“It was a big concern for me,”he says, “because we had very little income.”

Four years later he doesn’t even want a credit card and uses Interac or cash for everything—even a recently purchased used automobile.

A secured credit card is another solution. You put down a deposit (say, $500), allowing you to spend up to that amount on your card.

Hallmarks of a Healthy Budget

BY CAMILLA CORNELL

The average Canadian family brings in about $51,473 annually (after taxes). Scott Hannah, Executive Director of the Credit Counselling Society of British Columbia and a licensed credit counsellor offers the following guidelines for where that money should be going:

• As a rule of thumb, says Hannah, no more than 20 percent of your after-tax income should go towards servicing consumer debt (such as purchases on credit cards, department store cards, lines of credit and car loans or leases). “So if you’re earning $4,300 a month, then the maximum amount you should be paying out is $860, not including your mortgage.” Keep in mind that depending upon the type of car you own and amount of usage, your vehicle insurance and operating costs could amount to "another five to 10 percent off your net income,” he points out.

• Housing costs, including rent/mortgage, utilities, taxes and insurance, shouldn’t take up more than 35 percent of your after-tax income. On the average Canadian household income of $51,473, then, you shouldn’t be paying out more than $18,000 a year or $1,500 a month. Allocate another 5 percent for utilities.

• Food costs might take up anywhere from 15 to 20 percent of take-home pay for a family of three or four, although this can vary according to dietary restrictions and eating habits.

7. Contact your creditors. When you can’t make a payment, your first impulse maybe to ignore those accumulating bills. But, says Hannah, that’s the worst thing you can do. Creditors will assume you have no desire to pay them. Hannah advises calling the creditor the moment you suspect you’ll miss a payment. “If it’s a problem you can overcome within a few months, most creditors will work with you,”he says.

But if the situation is worse—you’ve lost your job or your marriage has broken down—provide verification in writing to your creditors. “That shows you’re the same responsible person,”says Hannah, “but you’re facing a problem.”

Next, arrange a payment plan you can handle. Creditors might let you reduce some payments. If you’re on the brink of bankruptcy, they may take less than what’s due because “they’ll get next to nothing if you declare bankruptcy,”says Hannah.

8. Call the collection agency’s bluff. After three to six months, debts may be turned over to a collection agency and, says Hannah, these people can be more difficult to deal with. But they are bound by provincial legislation.

“They’re not supposed to harass you or call you at work if you’ve asked them not to,”he points out.

Although they may threaten to, a collection agency cannot have you jailed, garnishee your wages or seize bank accounts unless they start legal proceedings and a judge rules against you.

And, says Hannah, “that’s warranted only when the person can resolve their debts but won’t.”So keep the agency informed about your situation.

Several years ago, when the Browns faced their first brush with bankruptcy and were getting eight to 12 calls a day from collection agencies, Stacey felt as if she was on the verge of a nervous breakdown. But after a credit counsellor assured her that the family were entitled to food, shelter and transportation to work, Stacey wrote a letter to each creditor detailing what she and Paul netted monthly (about $2,800), including copies of pay stubs.

She listed payments for rent, car, child care, insurance and utilities, and their $80-a-week allocation for groceries, diapers, presents and clothes. “There’s $98 left at the end of the month,”she wrote. “Here’s a list of everyone I owe. Your portion is X percent.”She included six postdated cheques. “Finally,”says Stacey, “there was silence.”

9 Get some free advice. Financial consultant Yaccato was herself a “credit-card junky”in her mid-20s. “There was an excitement about owning something new,”she says. “Long term, it was a nightmare.”Despite a six-figure income in sales, her debt kept rising.

When Yaccato could no longer take the “anxiety and sleepless nights,”she turned to the nonprofit Credit Counselling Service of Toronto and set up a consolidated repayment program and a budget. Nonprofit credit-counselling services operate in eight provinces. “They can save your life,”says Yaccato. Now a successful consultant and author of the book Balancing Act: A Canadian Woman’s Financial Success Guide, she sits on the board of the same organization that once put her on the path to financial success.

Getting your debts under control can have long-term benefits. When Hannah closes a client file, he suggests that since they’ve “got used to doing without that $400 a month,”they invest it to create a secure future. Tony Cortona took his advice. His debt paid and his second career in full swing, he recently bought an income property and moved in.

“This is good debt,”he says. “Most of the mortgage is paid by the tenant.”